Are The Stars Aligning For Emerging Market Investments?

By Salman Ahmed, Chief Investment Strategist Lombard Odier Investment Managers
Wednesday 21 September 2016

A legacy of years of ultra-low interest rates, high government debt, and subdued economic growth in developed markets around the world is that investment returns from all major asset classes are low and likely to remain low for some time.

As investors consider how to diversify away from these subdued fixed income and equity markets in search of better returns, many are finding that emerging markets (EM) offer both attractive value and better long-term growth prospects.

EM assets have not shared the recovery that developed markets experienced since the financial crisis of 2008/9. Instead many of these EM assets came under considerable pressure during the 2011/15 period due to a combination of weak economic fundamentals, geopolitical risks and the stronger US dollar.

We now believe conditions have changed for the better based on a risk/reward assessment that takes into account fundamental factors, valuations and risks. These factors combined means we think the case for investment in EM assets is now stronger than it has been in recent years.

Our assessment of various investment factors fundamentals including recent data, show an increase in economic activity and an improvement in both the current account balances and external debt profiles of a number of developing economies. In addition, inflation in many of these countries is trending lower.

From a valuation perspective, the current pricing of EM assets does not reflect any of these developments, or indeed, data showing that GDP growth in EM economies is once again outpacing that of developed economies.

An important point for investors to consider is that historically, when growth in EM outpaces that of developed markets, it is a reliable indicator in our view that EM asset outperformance will follow.

After more than five years of underperformance, EM asset prices, including equities, fixed income and currencies are showing signs of deep undervaluation. While this is starting to reverse, there remains a lot of room for EM valuations to catch up with developed markets, so this trend could continue.

EM asset valuations have experienced numerous shocks in recent years, including the Fed’s taper tantrum, fears around China meltdown and idiosyncratic risks such as Russia’s military intervention in the Ukraine and Brazil’s corruption scandal. These have all taken place in a backdrop of falling commodity prices and a stronger dollar.

We believe many of these risks have now subsided. Yet, valuations continue to reflect a level of risk reminiscent of the 1997-1998 Asian financial crisis.

Of the remaining concerns that could affect EM growth in the medium term, the prospect of higher interest rates in the US and potential systemic risks surrounding the state of China’s economic future continue to hold the attention of investors. In the US, the Federal Reserve has adopted a cautious stance despite strength of domestic data as the focus has turned towards weak international developments. But in China historic structural changes are still underway, so economic news from there requires close attention.

Investors’ concerns regarding China, which started in April 2015 with the sharp devaluation of CNY, generally revolved around fears of a slowdown of the economy and the very high level of debt. We believe China’s position as a net creditor to the world and the very liquid asset profile of its external balance sheet, provides a key backstop against the risk of a full financial meltdown. In addition, China still has around 3.2 trillion of reserve providing a large cushion in case of significant deleveraging of the economy.

EMs now offer a very attractive opportunity, especially in light of the low-yield environment in developed economies. However, those considering EMs should reflect on the different situations in fixed income and equities.

In fixed income, a new paradigm where central banks are dominant players and regulation has tightened means that today’s world is characterised by fractured liquidity and increased commonality in investors’ portfolio. In this context, moving away from traditional benchmarks which reward the most indebted countries and instead focussing on the issuers with the best underlying fundamentals in our opinion could prove a better option. An approach focusing on the quality of the issuers and requiring trading less frequently will lead to a portfolio which is less exposed to growing liquidity and market risks.

For EM equities, the situation is different and liquidity is much better. On this basis, investors should consider a high-conviction approach, which is where a fund manager uses skill to research each company within the EM equity universe and to know the factors that influence these companies return.

  1. How will young entrepreneurs change the face of wealth?
    [read more]
  2. How can private investment take space travel to new frontiers?
    [read more]
  3. How will Brexit shape Britain’s relationship with the continent?
    [read more]
  4. How can you invest as well as helping others?
    [read more]
  5. Is Fixed Income still a safe investment?
    [read more]

IMPORTANT INFORMATION – GENERAL MARKETING
This is a marketing communication issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter "Lombard Odier"). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This marketing communication is provided for information purposes only. It does not constitute an offer or a recommendation to subscribe, to purchase, sell or hold any security or financial instrument. It contains the opinions of Lombard Odier, as at the date of issue. These opinions and the information herein contained do not take into account an individual’s specific circumstances, objectives, or needs. No representation is made that any investment or strategy is suitable or appropriate to individual circumstances or that any investment or strategy constitutes a personal recommendation to any investor. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Lombard Odier does not provide tax advice. Therefore you must verify the above and all other information provided in the marketing communication or otherwise review it with your external tax advisors.
Some investment products and services, including custody may be subject to legal restrictions or may not be available worldwide on an unrestricted basis.
Investments are subject to a variety of risks. Before entering into any transaction, an investor should consult his/her investment advisor and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. The information and analysis contained herein are based on sources considered to be reliable. However, Lombard Odier does not guarantee the timeliness, accuracy, or completeness of the information contained in this document, nor does it accept any liability for any loss or damage resulting from its use. All information and opinions as well as the prices, market valuations and calculations indicated herein may change without notice.
Past performance is no guarantee of current or future returns, and the investor may receive back less than he invested. The value of any investment in a currency other than the base currency of a portfolio is subject to foreign exchange rate risk. These rates may fluctuate and adversely affect the value of the investment when it is realized and converted back into the investor’s base currency. The liquidity of an investment is subject to supply and demand. Some products may not have a well-established secondary market or in extreme market conditions may be difficult to value, resulting in price volatility and making it difficult to obtain a price to dispose of the asset.
European Union Members: This marketing communication has been approved for issue by Lombard Odier (Europe) S.A., a credit institution authorised and regulated by the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg and by each of its branches operating in the following territories: France: Lombard Odier (Europe) S.A.• Succursale en France, a credit institution and regulated in France by the Autorité de contrôle prudentiel et de résolution (ACPR) and by the Autorité des marchés financiers (AMF) in respect of its investment services activities. United Kingdom: Lombard Odier (Europe) S.A. • UK Branch, a credit institution regulated in the UK by the Prudential Regulation Authority (PRA) and subject to limited regulation by the Financial Conduct Authority (‘FCA’) and the Prudential Regulation Authority (‘PRA’). Details of the extent of our authorisation and regulation by the PRA and regulation by the FCA are available from us on request. UK regulation for the protection of retail clients in the UK and the compensation available under the UK Financial Services Compensation Scheme does not apply in respect of any investment or services provided by an overseas person.
Switzerland: This marketing communication has been approved for issue by Bank Lombard Odier & Co Ltd, a bank and securities dealer authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).
United States: Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
This marketing communication may not be reproduced (in whole or in part), transmitted, modified, or used for any public or commercial purpose without the prior written permission of Lombard Odier.
© 2016 Bank Lombard Odier & Co Ltd – all rights reserved

Top